In part 1 of our commentary on China Wednesday, we discussed the current Fundamental Gravity of our “Slowing Dragon” macro theme. If you missed part 1, I would encourage you to read that first, before jumping into part 2  with today’s trade idea, writes Landon Whaley.

We covered a great deal of critical economic and central bank developments, which are bearishly impacting Chinese equities and the US-listed ETF, iShares China Large Cap ETF (FXI).

The Fundamental Gravity bottom line is that Chinese economic data continues to slow, and the PBOC has brought a policy pea shooter to a growth slowing gun fight. Unless—and until—the PBOC ups the liquidity and easing policy ante, the trajectory for Chinese growth is down from here. But the Fundamental Gravity is just one of the three most critical forces, or gravities, impacting FXI.

Quantitative Gravity says what?

As a quick reminder, the Quantitative Gravity component of our Gravitational Framework is not technical analysis, which is ineffective and misleading. Rather, we use quantitative measures based on the reality that financial markets are a nonlinear, chaotic system.

We’ve identified four primary quantitative dimensions of financial markets that affect price movement: energy (trend), force (momentum), rate of force (buying pressure), and a market’s irregularity (level of imminent drawdown risk).

chart 1

Social is our measure of a market’s current energy (or trend). FXI’s Social reading indicates it’s experiencing a bearish hangover that no amount of IV fluids can help.

Momo is our measure of the amount of force behind the market’s current state. FXI’s Momo turned bearish on February 9 and has only been in bullish territory 16 trading days since. The current Momo reading is decisively bearish.

chart 2

Barometric is our measure of the rate of force behind the current Momo. FXI’s Barometric tells us that sellers remain firmly in control of this market, and selling pressure continues to build.

chart 3

Topo, which measures the probability of a drawdown, is indicating the drawdown risk for FXI over the next 10 trading days is extremely high.

chart 4

Most investors are hyper-focused on price action. Unfortunately, price is nothing more than the current point where there are equal parts of disagreement on value and agreement on price. If you’re new to our Quantitative Gravity framework, it’s important to note that the four quantitative dimensions of a market that we monitor typically move ahead of price.

In other words, price is the last aspect of a financial market to move, quantitatively speaking.

However, price is an important factor, and our bearish thesis for Chinese equities will remain intact, as long as FXI trades below $62.06.

The Quantitative Gravity bottom line is that despite last week’s dead cat bounce, FXI’s QG is still registering extremely bearish across all factors.

Behavioral Gravity says what?

Behavioral Gravity allows us to evaluate investors’ perception of this market and how that perception changes and shifts over time.

The iShares China Large Cap ETF (FXI) peaked on January 26 and has since declined 22.6%, officially entering crash mode. Despite this reality, investors have added $452MM in new money to this ETF during its crash mode time period. These folks are clearly not embracing a Gravitational Framework to evaluate financial markets.

The Behavioral Gravity bottom line is that despite decisively bearish Fundamental and Quantitative Gravities, investors continue to plow money into this market. This behavior is humanness on display, doing exactly the wrong thing at exactly the wrong time.

The Trade Idea

As long as FXI trades below $46.02, new short trade ideas can be initiated opportunistically on rallies. Depending on your entry and how much room you want to give this trade idea to move, use a risk price between $44.37 and $46.02. Your risk price line in the sand is $46.02. If FXI closes above that price, exit any open trades. If the trade moves in your favor and FXI trades down to the $41.26 area, consider closing some, or all, of your position.

In addition to providing detailed analysis and trade ideas like this commentary on a weekly basis, we also provide real-time email alerts whenever we add, or close, a position in our Asset Allocation model inside our Gravitational Edge report. We are currently short FXI in our Asset Allocation Model.

Please email us at ClientServices@WhaleyGlobalResearch.com if you’d like to participate in a an eight-week free trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358, and The Weekender.

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